Reverse Hedge.

Another variant of C-Booking is the reverse hedge which is when a customer’s trades are either partially or completely reverse hedged.

This practice is based on the assumption that a customer trades so poorly, it’s possible to make money by not only B-Booking the position but to ADD on to the B-Booked position!

Rather than another variant of “C-Book”, a more accurate name would probably be “B-Book+“.

Basically, the broker does not even try to hedge or transfer market risk, it purposely takes on MORE market risk!

When a broker chooses to “reverse hedge” a customer’s trade completely, it is basically increasing its B-Book risk.

Reverse Hedge Example

Elsa goes long 1,000,000 EUR/USD at 1.2001.

Since the broker is Elsa’s counterparty, it is now short 1,000,000 EUR/USD.

The broker is now exposed to market risk (if EUR/USD rises).

If we stop here, this would be B-Book execution.

Does the broker wish to A-Book the trade and completely hedge?

Nope.

It has profiled Elsa as an unprofitable trader so instead of completely or even partially hedging with an LP, it decides to “reverse hedge” 50% of the trade.

So instead of going long EUR/USD, which is what it would’ve done to cover its market exposure, it goes short 500,000 units with an LP!

Remember, it is already short 1,000,000 units against its customer. But it ADDED even more risk exposure with the additional 500,000 units against the LP.

In this scenario, the broker turned out correct.

EUR/USD did fall.

Elsa exited her trade with a loss, which translates to a gain for the broker.

But its trade with the LP also resulted in a gain.

As long as the broker chooses correctly which trade to “revere hedge”, this strategy can be very lucrative.

But if it chooses wrong, the risk it exposes itself to is even greater than if it had B-Booked the trades and would result in much bigger losses.

Here’s an example where it doesn’t go well for the broker.

Elsa goes long 1,000,000 EUR/USD at 1.2001.

Since the broker is Elsa’s counterparty, it is now short 1,000,000 EUR/USD.

Instead of going long EUR/USD, which is what it would’ve done to cover its market exposure, it goes short 500,000 units with an LP.

Remember, it is already short 1,000,000 units against its customer. But it ADDED more risk exposure with the additional 500,000 units against the LP.

EUR/USD rises.

Elsa exited her trade with a gain, which translates to a loss for the broker.

If the broker had A-Booked and opened a hedge trade with an LP, it would’ve had a gain from the LP to offset its loss with Elsa.

Instead, its trade with the LP also resulted in a loss.

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